Where UBS Goes, Other Banks May Soon Follow

UBS is the first bulge bracket investment bank to make
drastic strategic changes since the financial crisis, but few
would bet on it being the last. Other banks, notably European
rivals Deutsche Bank and Barclays, are breathing a sigh of
relief at the retreat of a competitor in a number of markets,
but sources say they are also watching closely to see if
UBSs gamble pays off.

The Zurich-based bank said on October 30 that it was largely
withdrawing from fixed income trading, reducing its funded
balance sheet by Sfr300 billion ($319 billion) or a third over
three years, and cutting headcount across the group by 10,000
or 16 percent of the total. Some 2,000 front office investment
bankers will be axed. Its a bold step.

There has to be an element of doubt about whether you
can run a successful investment banking division and equities
business without fixed income, but strategically it makes sense
to allocate capital to the strongest parts of the bank such as
wealth management, says Andrew Stimpson, banks analyst at
Keefe, Bruyette & Woods in London. This is a doubt shared
by former group CEO Oswald Grubel, who told Institutional
Investor in an interview in February 2011, you cannot run
a global bank without something as basic as fixed income
trading.

The reasons cited by CEO Sergio Ermotti for the shift in
strategy, however, could apply to a number of the leading
banks. In a conference call with analysts on October 30,
Ermotti said that many areas of fixed income have been
made uneconomic by changes in regulation and in the
markets.

Higher capital requirements now makes capital-intensive
fixed income business less attractive. UBS faces particular
challenges as a Swiss bank since it is required by regulators
to reach a core tier 1 capital ratio of 10 percent by 2019,
higher than Basel IIIs 7 percent. And UBS has not been
able to break into the top 5 in global fixed income trading.
Reports compiled privately for the big banks by Coalition Index
show that JP Morgan Chase, Deutsche Bank and Barclays are the
pre-eminent players in that market. Its such a
capital intensive business that you need to be in the top five
to make it worthwhile, says Frank Braden, banks analyst
at S&P Capital IQ in London. A UBS investor said,
There was a scale problem. With only $2.5 billion of
revenues in the third quarter of 2012, UBSs investment
bank is much smaller than most of its peers who typically
generate over $4 billion each quarter. Fixed income,
currencies and commodities typically account for half of
UBSs investment, but the Swiss group said it would stay
in the currencies markets as well as in certain areas of fixed
income closely related to its debt capital markets business,
without giving full details. This retreat will allow the bank
to cut risk-weighted assets in the investment by SFr 100
billion, some Sfr 60 billion more than previously announced,
down to Sfr 70 billion over the next five years.

UBSs ambition to deliver higher returns to its
shareholders meant it had to take radical action to jettison
less profitable businesses. Return on equity in UBSs
investment bank in the year to September 30 was 9 percent, well
below the cost of capital of around 12 percent, and well below
the level achieved in the happier days before 2008 when it
regularly managed over 15 percent. Ermotti told analysts he
wanted the investment bank to achieve ROE of at least 15
percent by 2014.

Some senior rival investment bankers doubt that UBS can make
a success of a firm shorn of a core product. Most clients
are multi-product users and some might choose to move to a
genuine universal bank. This is fraught with execution risk,
and its great news for the rest of the industry,
says one wryly.

One the other hand, if it is a success, other big banks with
relatively weak units might be tempted to emulate UBS, or Royal
Bank of Scotlands investment banking business which
exited its equities business piecemeal in the first quarter of
this year. Citigroup, for instance, as new CEO Mike Corbat will
note, has a comparatively small equities business that produced
only about a fifth of the $3.7 billion generated by fixed
income, currencies and commodities.

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